In today’s Finshots, we explain if the American government will shut down next week and what it means for the economy.

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The Story

The US government could shut down on 1st October!

Imagine the government machinery coming to an abrupt halt. Employees sitting at home with nothing to do and no pay. No economic data. Nothing on inflation. Politicians squabbling over money matters.

Sounds insane, right?

Now before we get into what on earth is going on, we know you might be thinking, “Hey, didn’t Finshots write about something like this in April?”

And you’d be right. Partially.

Because back then, the US was busy fighting over a debt crisis that would’ve entailed a possible default on loans. And in case you missed that story and you’re wondering what that was about, here’s a quick primer.

See, governments all over the world spend money from their tax revenues. If it isn’t enough for the big, ambitious plans, then they borrow money by issuing bonds. But if their income isn’t growing fast enough, they’ll be in a spot of bother. They’ll have to juggle their daily expenses along with repaying the principal and interest on the loans. And sometimes, the only way out is to borrow more money just to repay the old loans. It can be a vicious cycle.

That’s why the US has a rule in place to keep this sort of debt binge in check. The government has a hard stop on how much money it can borrow. This is called the ‘debt ceiling’. It’s a limit on borrowing more money if said money was used to meet some of its existing obligations — such as government salaries, pensions, and even the interest on current debt. The ceiling exists to prevent the country from going into that vicious cycle.

And the problem for the US was that it had hit the ceiling a few months ago. They couldn’t borrow more money. They were almost ready to default on loans. And then, all hell would break loose.

But when push comes to shove, they always end up finding a way to raise the ceiling or postpone the inevitable and avert a crisis. For instance, they hit pause and simply suspended the $31.4 trillion debt ceiling. They kicked the can down the road to January 2025 so that they could keep borrowing money till then.

But that’s not what’s happening now. This looming government shutdown is slightly different.

You see, every year, the US Congress — think of it as a parliament made up of people from both parties — has to decide how much money it can spend for the upcoming year. It’s an annual budget of sorts. And they have to pass 12 such Appropriations Bills. These bills determine the quantum of money that can be doled out to various government agencies such as Defence, Education, and Health to function smoothly. And this decision has to be made by the 30th of September each year. That’s the end of the fiscal or financial year in the US.

And if they don’t decide how much money they can spend, the employees at various government agencies won’t receive what they’re due. They won’t get salaries. Even some welfare schemes for food and childcare will remain penniless. And the US government will basically remain in a “shut down” mode.

That's the situation today. A group of Republicans (the party who's in the Opposition) think that the US government spending is out of whack and they want the Democrats (the folks in power) to cut back on what they deem to be unnecessary expenditure.

So does that mean the economy is going to be skewered while the politicians slug it out, you ask?

Not really.

For starters, these things are more common in the US than you’d think. Since 1976, the US government has pulled down the shutters on 20 occasions. Some of these shutdowns were just for a couple of days. Some others were much longer and lasted for a month. But overall, Morgan Stanley’s calculations indicate that there has been limited economic impact — on average, the economy still grows by 2.2% (after adjusting for inflation) during these times. Also, all these government workers who don't get paid will eventually make it all back. They get paid. So the loss in consumer spending could also be temporary. Because these folks will eventually head out and spend the money anyway.

Also, the lawmakers can kick this can down the road too. They can simply pass something called a ‘Continuing Resolution’. They’ll look at the spending for the previous fiscal year and extend that for a short while. At least until the lawmakers can tackle the impasse. In fact, since 1997, the deadline has actually never been fully met ever and these CRs have been used quite a bit.

And even if that doesn’t happen and the government does shut down like it has in the past, it won’t be economic mayhem. And that’s because these 12 bills only cover discretionary spending. That’s just about 30% of the total spending outlay. Everything else is mandatory spending that’s part of permanent law such as Social Security. There’s no debating it.

Put all this together and you see why investors know that the impact is limited. And quite weirdly, the S&P 500 stock market index historically gains 4.4% on average during these shutdowns.

So yeah, it does seem like even though the media is rife with news of the negative optical impact of a government shutdown, it’s just a blip that America is used to dealing with.

Until then…

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